Conservative Orthodoxy and Voodoo Economics

I’ve often noted that a major problem with the modern conservative movement and the Republican Party is that they put ideology before reality. As I recently noted, this can be seen in their rejection of science, including their views on evolution and global warming, their disputed claims about Iraq such as the presence of WMD and a connection to 9/11, their promotion of alternative history with their denial of the nation’s heritage of separation of church and state, their views on the near-absolute power of the Executive Branch, and in promoting what previously was called Voodoo Economics. Megan McArdle gives another example of how conservatives place ideology over reality on economics:

A conservative publication, which I will not name, just spiked a book review because I said that the Laffer Curve didn’t apply at American levels of taxation, even while otherwise expressing my vast displeasure with the (liberal) economic notions of the book I was reviewing. This isn’t me looking for an alternative explanation for the spiking of a bad review: the literary editor accepted it, edited it, and then three hours later told me it couldn’t be published because it violated their editorial line on taxation.

I suppose I ought to have known, but I didn’t. Go ahead liberals, pile on: you told me so. The Laffer Curve and the supply siders pushing it seem to be the teacher’s unions of the right.

Needless to say, the comment on the teacher’s unions brought about responses such as this from Matthew Yglesias.

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  1. 1
    The Charters Of Dreams says:

    Oh, I think you meant to say, on economics, conservatives put REALITY before ideology. It was probably just a little dyslexia operating in the posting, so don’t worry about it: the Laffer Curve curve is alive and well out there in the REAL world — to wit:

    A new study from the International Monetary Fund looks at what happened in Russia after the 13 percent flat tax was implemented and concludes that there was a Laffer Curve effect. Indeed, the increase in taxable income was so large that it completely offset the impact of the lower tax rate. In other words, this was one of the rare cases of a tax cut “paying for itself” (in the vast majority of cases, lower tax rates generate revenue feedback, but the net result is still less money for government).

    Interestingly, the study finds that the additional revenue materialized because people are more willing to obey the law when the tax rate is low, as theory would predict, but did not find an increase in labor supply, which theory also would predict (See? No theory is prefect). This anomaly aside, it is still good news that the IMF recognizes that there is a Laffer Curve and that high tax rates are needlessly destructive.

    Details from the papaer (and that great place called “reality”):

    …The Russian flat tax experiment is particularly interesting: after the introduction of flat taxes, and effective personal income tax rate cuts, tax revenues increased substantially and almost immediately. Furthermore, they increased much faster than labor supply and output. The paper explains how tax rate cuts can increase tax revenues through tax compliance spillovers in such a manner.

    …This paper shows that endogenous tax compliance responses can be responsible for the massive increase in tax revenues. The key intuition is that tax regimes are prone to spillovers, as the aggregate behavior of taxpayers determines how much time the tax authority can dedicate to the individual taxpayer. In a way, tax evaders protect each other by tying down the tax authority’s limited capacity. Hence, small cuts in the tax rates can lead to much larger changes in the behavior of taxpayers — most importantly, it can make them much more likely to declare their incomes honestly. These spillovers can lead to increasing tax revenues.

    …taxpayers evade less tax payments when the tax rate is lower… evasion increases with the tax rate.

    …Three cases could be highlighted. First, countries with high official tax rates and relatively weaker tax authorities, such as some of the transition economies, might benefit from tax rate cuts and improving compliance. Second, the model might be also relevant for countries with high tax rates, even if tax enforcement seems to be strong in absolute terms. Third, low tax countries which have particularly weak tax enforcement could also think about improving tax compliance via tax rate cuts.

  2. 2
    Ron Chusid says:

    You think this is reality? You are basically demonstrating how conservatives ignore reality on economics.

    I don’t know of anyone who doesn’t agree that under certain situations a lower tax rate will bring in more revenue. Where conservatives deny reality is to believe that the Laffer Curve is a general rule as opposed to a phenomenon which only occurs in certain situations.

    When you have to resort to an example in Russia, where there are many additional variables it only highlights how weak the argument is.

    Resorting to the Laffer Curve as a general rule is simply a way to deny reality in claiming you can cut taxes at any time without reducing spending.

  3. 3
    The Charters Of Dreams says:

    Please! Liberals lack of understanding of how science really works is only surpassed by their almost complete cuelessness about economic issues.

    First, the GOP didn’t collapse because of “Voodoo” economics unless your definition of Voodoo economics includes pushing overspending, pork and earmarks (if it does, then my apologies) — see Leviathan on the Right: How Big-Government Conservativism Brought Down the Republican Revolution.

    Second, I’m not sure what Megan McArdle really means when he says “the Laffer Curve didn’t apply at American levels of taxation” because apparently his review wasn’t published, however, I’ll assume that Mr. McArdle makes the argument that marginal rate in the United States is 35%, and no one in their right mind thinks that’s anywhere near high enough to have a serious Laffer effect. When top rates are that low, lowering them further just reduces tax revenue.

    Now — you’re absolutely correct that it is a denial of reality to believe that “you can cut taxes at any time without reducing spending.” However, the Laffer Curve has nothing (that I know of) to do with the claim.

    The left’s critique of the Laffer Curve is based on the straw-man proposition that tax cuts are self-financing (see my first comment where I stated this outcome is rare). Notwithstanding some of the political rhetoric, the Laffer Curve does not imply and never has implied that all “tax cuts pay for themselves. That only happens if rates become sufficiently punitive to put the taxing jurisdiction on the downward-sloping portion of the curve.

    The real issue is whether certain changes in tax policy will have some impact on economic activity. If an increase (decrease) in tax rates changes behavior and causes a reduction (increase) in taxable income, then revenues will not rise (fall) as much as “static” revenue-estimating models would predict. This is hardly a radical concept, and evidence of Laffer-Curve effects is very well established in the academic literature.

    The reason there is a debate is that the government’s revenue-estimating bodies (the Joint Committee on Taxation on the Hill and the Office of Tax Analysis at Treasury) assume that tax policy changes have zero impact on economic performance, and that is worse than whatever you mean by “voodoo” — it’s (pardon my French) bulls**t!.

    For example, if the entire tax code was scrapped and replaced by a low-rate flat tax, JCT and OTA would assume no effect on macroeconomic aggregates. If tax rates were doubled, JCT and OTA would plug new numbers into their simplistic (yet totally nontransparent) models and estimate that tax revenues would double.

    OK — here’s “reality:”

    Not all tax cuts (or tax increases) are created equal. An increase in the personal exemption or the child credit will have very little, if any, impact on incentives to work, save, and invest. As such, the “static” estimate of revenue losses will be reasonably accurate. A reduction in the tax rate on capital income, by contrast, will substantially alter incentives for taxpayers who have considerable ability to adjust their behavior. This will result in a Laffer-Curve response, though it is an empirical question whether the revenue feedback will offset 20 percent, 50 percent, or 75 percent of the static revenue loss (timing is also important since a tax rate reduction that yields a revenue feedback of 20 percent in the first year may generate a much larger revenue feedback five years in the future). So, just like issues surrounding climate change, there’s an empirical question of the causal variables and their relative effects — this is always in issues in just about every area of science, something that “man is certain and only real cause of climate change” true believers never quite get (which makes them true believers, I guess).

    The left is very clever (if not that well educated): Defenders of the status quo have created a straw man, and they find quotes from politicians and others with little knowledge to create the impression that advocates of lower tax rates believe in the fiscal version of a perpetual-motion machine. This tactic is then used to prop up the existing system of revenue estimating, which is based on assumptions that would earn an F if put forth by a student in an undergraduate public finance course.

    The Laffer Curve, properly understood, is very good in predicting and explaining human economic behavior. Since you’ve dismissed Russia out of hand, I’ll give you new examples:

    From the Falls Church News-Press:

    “With another big hike, 75 cents a pack, in its cigarette tax put into effect last July 1, the City of Falls Church City Council asked for a spot check on the impact from the City’s Chief Financial Officer John Tuohy after the first quarter of the fiscal year, and he reported this Monday that July-September net revenues were down from the previous three years.”

    While the city’s CFO wants to believe this is because of a national trend of decrease smoking, government data showing that smoking rates have been flat in recent years. In “reality” local taxpayers are responding to the city’s sharp increases in the cigarette tax rate in recent years.

    The Laffer Curve is alive and well and explaining human economic behavior in Iceland:

    The WSJ reports that that corporate tax revenue has jumped dramatically in Iceland, even though the corporate tax rate has been slashed to 18 percent. The “reality” is that revenues jumped because of the lower tax rate. Iceland is a clear example of the Laffer Curve. As the rate fell, companies had less reason to avoid taxes. The low rate also encouraged additional economic activity. Iceland’s workers are the biggest winners, of course, since they now enjoy higher incomes and more prosperity:

    “The benefits of low taxes are on full display in Iceland, which provides an almost perfect demonstration of the Laffer Curve. From 1991 to 2001, as the corporate-tax rate fell gradually to 18% from 45%, tax revenues tripled to 9.1 billion kronas ($134 million in today’s exchange rate) from just above 3 billion kronas. Since 2001, revenues more than tripled again to an estimated 33 billion kronas last year. Personal income-tax rates were cut gradually as well, to a flat rate of 22.75% this year from 33% in 1995. Meanwhile, the economy averaged annual growth rates of about 4% over the past decade.”

  4. 4
    Ron Chusid says:

    “Please! Liberals lack of understanding of how science really works is only surpassed by their almost complete cuelessness about economic issues.”

    You lose any chance of being taken seriously right at the start. It is among conservatives that we find so many people who deny evolution, geology, cosmology, and the scientific consensus on climate change because it contradicts their religious views or what they desire to be true.

    Defending the Laffer curve based upon the times that it appears to be right only proves that think you can choose your reality based upon what you wish to be true.

    Neither scientific or economic reality is affected by what you wish to be true. You can continue to deny reality all you want, but that does not change reality.

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